Question

Forrest Gardner, owner of Gardner's Gardens, just completed his first year in business and has received financial statements that have been prepared by his accountant. Gardner finds the income statement and balance sheet to be informative, however, he does not understand the statement of cash flows. He says that the first section is especially confusing and does not understand why the income statement can't be used to get an understanding of cash flows from operating activities. Write a summary explaining the following: 1. Purpose and sections of the cash flow statement. 2. Explain why the first section may be confusing. Please review the attached grading rubric prior to completing the assignment.

Answer 1

A cash flow statement is used to understand the liquidity position of the organization. A balance sheet can tell the funds possessed by the company and an income statement is useful for projecting the profitability of the company, however a cash flow statement is extremely necessary to run the business smoothly. The cash flow from operations section is necessary to understand the cash flow generated from the regular business of the company. The cash flow from investment section is necessary to understand the cash flow generated from the investments made by the company. The cash flow from financing section is necessary to understand the cash flow generated from the financing activities undertaken by the company.

The operating section of the company might be a little confusing as it is reconciles net income to the cash flow from operating actvities using comparative data of current assets and liabilities between two years or using the direct method. It can be difficult to understand, however it can be simplified if the main motive is kept in mind i.e. determining the cash flows generated from regular business.